Over the past two weeks, three of Northlake's media long positions reported second quarter 2010 earnings. In addition, the recently sold DirecTV (DTV) reported results. The other three companies to report were CBS, Discovery Communications (DISCK), and Virgin Media (VMED). All four companies met or exceeded consensus estimates on most important financial and operating metrics. Guidance and/or commentary on the second half of 2010 and 2011 was positive and generally better than current consensus estimates. CBS, VMED, and DTV shares responded positively, while DISCK pulled back after reaching an all-time high on the eve of the report.
CBS comfortably beat estimates across the board driven by double-digit advertising growth and excellent controls. Following a couple of quarters where programming investments offset advertising recovery, 2Q10 revealed the operating leverage inherent in CBS' ad heavy business model. Management was firm in noting that cost controls would remain for the long-term. CBS has refinanced and improved its balance sheet which will lead to an announcement of higher dividends or a large share repurchase before year end. If the economy holds together, CBS shares can trade to the upper teens.
DISCK reported accelerating domestic advertising growth of 13% and continued 20% plus ad growth outside the US. Management made very constructive comments about long-term margin expansion and outlined plans for development of the new kids network, The Hub, and the Oprah Winfrey Network, OWN. The Hub launches in the fall and OWN in January 2011. With accelerating momentum in core channels like Discovery, TLC, and Animal Planet about to be accompanied by the elimination of startup losses and potential value creation at the new nets, DISCK shares can trade to the mid to the upper $40s. Helping matters is a long awaited announcement that the company will begin to buyback shares via a $1 billion authorization. This should be especially helpful to the DISCK shares which trade at over a $4 discount to the DISCA shares for no good reason. Management indicated they will buy back the shares "that make the most economic sense." It seems pretty obvious to me that would the DISCK shares.
VMED continues to benefit from its superior broadband network, improved competitive position in TV programming, and very effective management. Growth in financial and subscriber measures continues to pick up leading to very strong free cash flow that has dramatically improved the company's balance sheet and set up the potential for large share repurchases. Much of this positive outlook has been evident for over a year but the European sovereign debt crisis and the UK's weak economy and deep austerity policy kept the shares under pressure. An easing of the crisis, most evident in sharp rallies in the Euro and Pound, has allowed VMED's improving operating and financial performance to take center stage. The shares are nearing my initial target in the low $20s and may be due for some trimming but financial performance arguably justifies a higher target and suggests holding a core position makes sense.
DTV was sold from Northlake accounts ahead of its earnings report as I feared a slowdown in subscriber growth would lead to even more competitive conditions in the battle for subscribers in the mature pay TV industry in the US. My sell decision turned out to be incorrect as DTV reported better than expected US subscriber growth accompanied by higher ARPU (average revenue per unit or subscriber). Furhtermore, the rapidly growing Latin America operations accelerated again thanks to the World Cup. DTV raised its 2010 guidance at both business segments and authorized another large share repurchase. I still think competitive conditions in the US could upset the otherwise excellent DTV story and 2Q10 results did see a sharp increase in subscriber acquisition costs as the company is now giving HD away for free. However, extremely aggressive share repurchases, strong focus on segmented, higher end US subs, and rapidly growing LatAm operations should support the stock at current or higher prices.
Disclosure: CBS, VMED, and DISCK are widely held by clients of Northlake Capital Management, LLC, including in Steve Birenberg's personal accounts. Steve Birenberg is sole proprietor of Northlake. CBS, VMED, DISCK, and DTV are net long positions in the Entermedia Funds. Steve Birenberg is co-portfolio manager, an owner of the Funds' investment management company, and has personal monies invested in the Funds.